M&A Activity in Software Stocks is a Bright Spot for Technology Sector

Private equity firms have recently been increasing their acquisitions of software companies, boosting technology stocks.  Last week alone, there were three private equity deals for software makers worth $19 billion.  According to Bloomberg data, eight private equity takeovers with more than $1 billion have been announced in the past six months.

Despite the turmoil in the banking industry in the wake of the collapse of Silicon Valley Bank, the buyout trend in software stocks is continuing.  The iShares Expanded Tech-Software Sector ETF (IGV), a fund that tracks the sector, has seen over $200 million in inflows this year.  Around $89 billion in deals involving U.S. technology companies have been announced in the past six months, with $77 billion involving software companies.

Some analysts and fund managers believe there could be even more acquisitions in software companies since valuations have dropped amid a jump in interest rates and uncertainty about the outlook for economic growth.  Value Point Capital said, “software businesses are very cash generative and have recurring revenue streams.  It’s a very attractive business to add value to either through leverage or through a change in the company’s structure, and it’s a reasonable business to see an exit five years down the road.”

Renewed appetite from private equity firms is a bright spot for software stocks.  RBC Capital Markets’ list of most likely M&A targets in the sector includes Zoom Video Communications (ZM), Splunk (SPLK), Dropbox (DBX), and Smartsheet (SMAR).  The list previously included two companies that have already agreed to buyouts this year, i.e., Duck Creek Technologies (DCT) and Sumo Logic (SUMO).  PenderFund Capital Management said, “target companies with shareholders frustrated are also motivated sellers.  Along with motivated buyers, it makes for a perfect environment for deal activity.”

Although valuations for companies in the S&P 500 software and services group have declined recently, they still are not cheap at about six times the revenue projected over the next 12 months, above the 10-year average of 5.4 times.  The valuations have fallen back from a high of about 9 times in late 2021.  RBC Capital Market said, “private equity still has tons of dry powder, and during this period of economic uncertainty, it creates an ideal environment for them to step in and either focus on profitability or try to combine assets to create a larger platform.”

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